India inflation-linked bonds beat 10-year benchmark

The spread between the nominal returns on these inflation-indexed bonds and the 10-year bond currently stands at 1.55%. Photo: Pradeep Gaur/Mint

Updated: Tue, Jun 04 2013. 10 09 PM IST

Mumbai: The Reserve Bank of India (RBI) on Tuesday sold Rs.1,000 crore of inflation-indexed bonds due in 2023 and offering a 1.44% real rate of return.

Nominal returns on these bonds are linked to the wholesale price index in January, which was recorded at 7.31%.

This effectively means nominal returns of 8.75% (1.44% plus 7.31%), which is higher than the current returns given by the 10-year government security, bankers said. The 10-year 7.16% bond due in 2023 closed at 7.20% on Tuesday.

“1.44% is the premium they are offering over the inflation, which means these bonds will yield higher in terms of purchasing power parity compared to similar tenure bonds,” said N.S. Venkatesh, head of treasury at IDBI Bank Ltd.

To be sure, the spread between the nominal returns on these inflation-indexed bonds and the 10-year bond currently stands at 1.55%.

Gangadhar Darbha, an executive director with a Japanese investment bank, said the inflation-indexed bonds offer a useful hedge against inflation but the real test will be when inflation and inflationary expectations rise.

“There is an option for the RBI to reset the yield after six months, but if inflation or inflationary expectations go out of control, the risk premium that the government will pay will increase, which in turn will increase the fiscal deficit and likely stroke further inflation,” Darbha said.

Inflation expectations are down as wholesale prices have fallen since January to 4.89% in April. Since January, inflation has averaged 6.36% in 2013, down from 7.50% in the same period last year.

Darbha said the 5.76% difference between the cut-off in the inflation-indexed bonds and the current 10-year bond yield should be seen as the likely average inflation expectation for the next few months.

Tuesday’s Rs.1,000 crore sale was the first of at least Rs.12,000 crore of bonds RBI plans to issue in 2013-14, as announced in the Budget for the year.

RBI has clarified that these bonds will not get any special tax treatment but will count towards the statutory liquidity ratio (SLR) requirements of banks. SLR is the mandatory investment Indian banks have to make in government securities, currently at 23% of deposits. Most banks hold government securities in excess of this level.

RBI received 167 bids for bonds worth Rs.4,616 crore from banks and primary dealers, the auction results put up on its website on Tuesday show. The bonds will henceforth be sold regularly through auctions on the last Tuesday of each month during 2013-14.

The first series of the bonds till October will only be open to institutional investors through auctions to help RBI determine the coupon rate and create a benchmark. A retail issue is proposed around October.

The bonds were issued with an aim to “protect savings of poor and middle classes from inflation and incentivize household sector to save in financial instruments rather than buy gold,” RBI had said.

Gold imports

In a separate notification, RBI said gold can be imported into the country without any restriction only by jewellery exporters. This is the latest attempt by the central bank to curb consumption of the precious metal that is widening India’s trade gap.

Imports of gold surged 138% in April to $7.5 billion from a year ago, and were up 72% from March. India imports about $50 billion of gold every year.

Venkatesh of IDBI Bank said inflation-indexed bonds will give investors an alternative to gold. “These bonds will always be indexed to inflation so investors do not have to be bothered about returns once they buy and hold,” he said.